US Real Estate Market to Bottom in 2009

According to analysts, commercial real estate faces its worst year since the wrenching 1991–92 industry depression. The latest ULI and PwC joint market report includes interviews and survey responses from more than 600 leading real estate experts, including investors, developers, property company representatives, lenders, brokers and consultants. In general, interviewees believe that financial institutions will continue to be pressured into moving bad loans off balance sheets, using auctions to speed up the process. Investors will be discouraged until the “bloodletting” is over, states the report. When that occurs, cash and low-leverage buyers will be “king;” surviving banks will impose strict lending guidelines; commercial mortgage-backed securities will revive, but in a more regulated form; and opportunity funds will need new investment models.

“The industry is facing multiple disconnects,” said ULI Senior Resident Fellow for Real Estate Finance Stephen Blank. “Many property owners are drowning in debt, lenders are not lending, and for many industry professionals, property income flows are declining. There is an unprecedented avoidance of risk. Only when financing gets restructured will pricing reconcile, giving the industry a point from which to start digging out of this hole.”

“The cyclical real estate markets always come back, and they will this time too, but not anytime soon,” said Tim Conlon, Partner and U. S. Real Estate Sector Leader, PricewaterhouseCoopers. “Commercial real estate was the last to leave the party, will feel the pain in 2009, and may be the last to recover. In the meantime, smart investors are going to hunker down and manage through these tough times. We expect to see patient, disciplined, long-term investors rewarded, and return to a back to basics approach to property management, underwriting and deal structure.”

Distress in the housing market is benefiting the apartment market, which the report lists as the number-one “BUY”. Moderate-income apartments in core urban markets near mass transit offer the best buy, a trend that carried over from the previous year. Commercial markets will recover more quickly than most housing markets, and homebuilders may have to sell land tracts for “cents on the dollar” or face foreclosure on their holdings, adding to the already high rate of mortgage defaults and foreclosures.

The main beneficiaries of the real estate downturn in the U. S. are cash-rich offshore buyers, whom the report predicted will continue to take advantage of the weak dollar, and will buy trophy properties in major 24‑hour cities.

Suggestions for managing through 2009:

– Investors should sit tight. Opportunities will surface at significant discounts.

– Buy discounted loans.

– Recap distressed borrowers – invest in maturity defaults, construction loans/bridge loans, or take mezzanine positions and equity stakes in properties.

– Invest in publicly-held real estate investment trusts (REITs) – they will lead the market’s recovery.

– Focus on global pathway markets – 24‑hour coastal cities.

– Staff up asset managers, leasing pros and workout specialists. Separate good assets from bad.

– Retrench on development and reorient to mixed-use and infill. Higher-density residential with retail will gain favor in next round of building.

– Go green – cutting energy expenses is likely to be a priority.

– Buy or hold multi-family; hold office; hold hotels; buy residential building lots, but be prepared to hold.

– Purchase distressed condos in urban areas near transit.

– Focus on neighborhood retail centers with strong grocery anchors and chain drugstores.